11.10.2015, 9:10:00 AM

Recently, Fitch announced its new views regarding credit risks it believes may be inherent in protected cell captive insurance companies ("PCCs"). This questioning of the structure of PCCs is in light of Pac Re 5-AT v. AmTrust North America, 2015 WL
2383406 (D. Montana, May 13, 2015 ).

A protected cell company is a captive insurance company composed of (1) a “core” and (2) a number of “cells” which are established around the core.&nbs;Unless
limited by statute or regulatory rule, there can be an unlimited number of cells.&nbs;The assets and liabilities of each cell are segregated from the assets and liabilities of every other cell, as well as from the core.&nbs;The PCC structure was designed so that the assets of each cell are only available to
creditors of that cell.&nbs; Once a PCC is established by a sponsor, the sponsor can then operate each cell as an independent insurance company.&nbs;Or, more commonly, the sponsor can operate the core and other, non-related companies can operate each cell as independent insurance companies.&nbs;The cell structure –
and its shared overhead – permits smaller companies who do have the capability or desire to operate a single parent captive insurance company to obtain some
of the benefits of captive insurance.&nbs;

In Pac Re 5-AT v. AmTrust, a contract dispute regarding a captive reinsurance agreement between a cell and its reinsurer (which was subject to arbitration) broadened into an issue of first impression regarding protected cell companies. Originally, the dispute was between the reinsurer and the one single protected cell (Pac Re 5-AT a/k/a Cell 5) under the terms of the captive reinsurance agreement. However, the reinsurer named both the cell and the core (Pacific Re, Inc., a Montana captive insurance company) as a party as well. Pacific Re then sought a declaratory and injunction in federal court that it was not a party to the arbitration.

Stating that this was an issue of first impression under Montana law (and indeed, an issue of first impression under all domestic United States law), the court stated in pertinent part:

The statutory construction issue arises
here because a cell is not a separate de jure legal entity, but has many
de facto aspects of a legal identity.&nbs;It
is clear that the liabilities and assets of a protected cell are segregated
from the other cells and from the PCC, but it is also clear that a protected
cell does not have a separate legal identity.
Each cell, in essence, operates as its own separate entity, but remains
part of the larger PCC.&nbs;Though the
statute does not contemplate that the assets of a protected cell will be used
to satisfy the liabilities of any other cell, the cells are not entirely
independent from the PCC.

The court went on to rule that:

“A protected cell is not a
separate legal person.&nbs;Without a separate legal identity, and absent a statutory grant to the contrary, a protected cell does not have the capacity to sue and be sued independent of the larger PCC.&nbs;The statutory language is clear, and the court may not look beyond the plain meaning.&nbs;Although a protected cell has many attributes of independence from the PCC, it remains a part of the PCC, which has the capacity to act on behalf of the protected cell as in this instance Pacific Re
acted on behalf of Cell 5 in agreements at issue.”&nbs;

In summary, “Pacific Re, as the PCC, entered into contracts at issue, both on its own and on behalf of the protected cell.&nbs;It is properly before the
arbitration tribunal and will appropriately be bound by the results of the arbitration.”

As Fitch points out, the Pac Re 5-AT opinion raises significant concerns regarding how well "ring-fenced" each cell in a PCC is, and what would happen to a cell if another unrelated cell caused the core of a PCC to become insolvent.

North Carolina recently revised its captive insurance statute with a number of technical corrections. Under N.C.G.S. § 58-10-510, “a protected cell captive insurance company licensed under this Part may establish and maintain one or more incorporated or unincorporated cells, to insure risks of one or more participants. . . [ subject to certain conditions].”

Section 58-10-512 goes on to outline in more detail the formation, operation, and obligations under an incorporated cell captive program. This passage deals squarely with the issue raised by Pac Re 5-AT . The statute specifically states that:

"In the case of a contract or obligation to which the protected cell captive insurance company is not a party, either in its own name and for its own account or on behalf of a protected cell, the counterparty to the contract or obligation shall have no right or recourse against the protected cell captive insurance company and its assets other than against assets properly attributable to the incorporated protected cell that is a party to the contract or obligation."

As Pac Re 5-AT shows, understanding the applicable corporate law and captive insurance law of any domicile is important not just to those operating PCCs, but to anyone dealing with them as well.